(Photo | Pixabay)
You know how important it is to plan for your retirement, but where do you begin? One of your first steps should be to estimate how much income you’ll need to fund your retirement. That’s not as easy as it sounds, because retirement planning is not an exact science. Your specific needs depend on your goals and many other factors.
Use Your Current Income as a Starting Point
It’s common to discuss desired annual retirement income as a percentage of your current income. Depending on whom you’re talking to, that percentage could be anywhere from 60% to 90%, or even more. The appeal of this approach lies in its simplicity, and the fact that there’s a fairly common-sense analysis underlying it: Your current income sustains your present lifestyle, so taking that income and reducing it by a specific percentage to reflect the fact that there will be certain expenses you’ll no longer be liable for (e.g., payroll taxes) will, theoretically, allow you to sustain your current lifestyle. However, if you intend to travel extensively, you might easily need 100% or more of your current income!
Project Your Retirement Expenses
Your annual income during retirement should be enough to meet your retirement expenses. That’s why estimating those expenses is a big piece of the retirement planning puzzle. But you may have a hard time identifying all your expenses and projecting how much you’ll be spending in each area, especially if retirement is still far off. To help you get started, here are some common retirement expenses:
- Food and clothing
- Housing: Rent or mortgage payments, property taxes, homeowners insurance, property upkeep and repairs
- Utilities: Gas, electric, water, telephone, cable TV
- Transportation: Car payments, auto insurance, gas, maintenance and repairs, public transportation
- Insurance: Medical, dental, life, disability, long-term care
- Health-care costs not covered by insurance: Deductibles, co-payments, prescription drugs
- Taxes: Federal and state income tax, capital gains tax
- Debts: Personal loans, business loans, credit card payments
- Savings and investments: Contributions to IRAs, annuities and other investment accounts
- Recreation: Travel, dining out, hobbies, leisure activities
- Care for yourself, your parents or others: Costs for a nursing home, home health aide or other type of assisted living
Don’t forget that the cost of living will go up over time. Although we are experiencing high inflation currently, the average annual rate of inflation over the past 20 years has been approximately 2.5%.¹ And keep in mind that your retirement expenses may change from year to year.
Decide When You’ll Retire
To determine your total retirement needs, you can’t just estimate how much annual income you need. You also have to estimate how long you’ll be retired. Why? The longer your retirement, the more years of income you’ll need to fund it. The length of your retirement will depend partly on when you plan to retire. This important decision typically revolves around your personal goals and financial situation. For example, you may see yourself retiring at 50 to get the most out of your retirement. Maybe a booming stock market or a generous early retirement package will make that possible. Although it’s great to have the flexibility to choose when you’ll retire, it’s important to remember that retiring at 50 will end up costing you a lot more than retiring at 65.
Identify Your Sources of Retirement Income
Once you have an idea of your retirement income needs, your next step is to assess how prepared you are to meet those needs. In other words, what sources of retirement income will be available to you? Your employer may offer a traditional pension that will pay you monthly benefits. In addition, you can likely count on Social Security to provide a portion of your retirement income. Additional sources of retirement income may include a 401(k) or other retirement plan, IRAs, annuities and other investments. The amount of income you receive from those sources will depend on the amount you invest, the rate of investment return and other factors.
Make Up Any Income Shortfall
If you’re lucky, your expected income sources will be more than enough to fund even a lengthy retirement. But what if it looks like you’ll come up short? Don’t panic — there are probably steps that you can take to bridge the gap. A financial professional can help you figure out the best ways to do that, but here are a few suggestions:
- Try to cut current expenses so you’ll have more money to save for retirement
- Shift your assets to investments that have the potential to substantially outpace inflation (but keep in mind that investments that offer higher potential returns may involve greater risk of loss)
- Lower your expectations for retirement so you won’t need as much money (no beach house on the Riviera, for example)
- Work part-time during retirement for extra income
- Consider delaying your retirement for a few years (or longer)
¹Calculated form Consumer Price Index (CPI-U) data published by the Bureau of Labor Statistics, January 2023
Provided by Ed Wettig, CFP, Cornerstone Financial Planning Group, which offers investment management, financial planning and retirement income strategies. Representative is registered with and offers only securities and advisory services through PlanMember Securities Corporation, a registered broker/dealer, investment advisor and member FINRA/SIPC. 6187 Carpinteria Ave, Carpinteria, CA 93013, 800-874-6910. Cornerstone Financial Planning Group and PlanMember Securities Corporation are independently owned and operated. PlanMember is not responsible or liable for ancillary products or services offered by Cornerstone Financial Planning Group or this representative.
